It shouldn’t be surprising to anyone that the so-called Congressional Super Committee admitted defeat last week after failing to reach a compromise that would reign in Federal budget deficits by at least $1.2 trillion or more.¹

You certainly didn’t need supernatural powers of prediction, as some financial pundits claim to possess, to make this call. In fact, this outcome was completely predictable. The Committee’s failure was just the latest victim of super-divisive politics as usual in Washington DC.

The good news is that the budget impasse on its own will most likely have little or no meaningful impact on the US economy.

Far from being the Armageddon scenario that the merchants of doom like to claim, the fact that the Super Committee accomplished nothing may actually be a positive for deficit hawks. That’s because the way the law is currently written, if Congress takes no action at all — something they seem very good at — we still get an expected deficit reduction of $7.1 trillion over the next decade.²

That’s why this anxiety over a failed budget deal seems like much ado about nothing in our view. Let’s set aside the fear-mongering tactics and take a closer look at the actual numbers.

‘Mandatory’ Spending Cuts Amount to a Rounding Error

First, the lack of a deficit reduction plan doesn’t spell out a disaster scenario for US financial markets or our economy. And it doesn’t mean an imminent downgrade for America’s credit rating to banana-republic status either, contrary to what some peddlers of panic may tell you.

There will be absolutely NO impact on government spending this year and very little impact in 2012. Remember, the mandatory spending cuts we’ve heard so much about are spread out over the next decade … and don’t even begin to kick in until January 2013 — more than a year away.³

Second, the mandated spending cuts are relatively minor compared to the size and strength of our overall economy. One fear-mongering pundit claimed that the committee’s failure will lead to “spending cuts that will surely cripple our feeble economy…” but this misguided math couldn’t be further from the truth.

Between now and 2013 Congress still has time to reach a compromise over a combination of spending cuts and revenue increases. But even if they do nothing (as many expect), triggering a full $1.2 trillion in spending cuts over the next 10 years, this amount equals just six-tenths of one percent of total US GDP over the period — and just 2.7 percent of the total federal budget — according to Congressional Budget Office data.⁴

Rather than “crippling” our economy the $1.2 trillion in spending cuts amounts to the size of a rounding error for the US economy as a whole.

Third, if Congress continues to do absolutely nothing at all, deficits would be reduced by more than $7.1 trillion over the next 10 years and the federal budget would be nearly balanced by 2021. Most of this deficit reduction comes from temporary tax cuts scheduled to expire at the end of next year anyway, plus mandatory cuts in defense and non-defense spending that Congress agreed to earlier this year in the Budget Control Act that created the Super Committee.⁵

Sure, in a perfect world, Congress would be able to put aside its partisan bickering and come together on a deficit reduction compromise that includes both long-term spending cuts and revenue increases, perhaps by simplifying the existing tax code. But of course Washington DC is FAR from perfect these days … and lest we forget that 2012 is an election year too!

Apocalypse? … Not Now

Despite the latest round of government fumbling — on both sides of the Atlantic — investors would do well to keep events in perspective and not get spooked by the self-interested pundits of pessimism.

Far from being an apocalyptic scenario for our economy, the budget impasse is simply business as usual in Washington, and from an investment standpoint it is likely to have nominal impact in the near term.

What’s more, the dollars being discussed in terms of mandatory spending cuts are just a drop in the bucket compared to the size of the federal budget … and even more insignificant measured against the overall size of our economy.

In fact, it’s easy to argue that Congress’ failure is perhaps good news for the economy and for deficit reduction in the long run. That’s certainly the way financial markets seem to be interpreting it so far.

Here we are several weeks after rumors of the Super Committee’s failure first began to make the rounds … and several months after our nation’s credit rating was cut … and yet financial markets don’t seem to be signaling any titanic loss of confidence in the US.

If this were really the disaster scenario that the merchants of doom claim it to be, then you would expect the US dollar to be plunging in value. And you would expect interest rates to soar as investors dump US Treasury bonds.

But is that what’s happening? No! In fact it’s just the opposite.

Since August 5 when Standard & Poor’s downgraded the US credit rating, the dollar has soared 7.2 percent ...

US Treasury bonds have been one of the world’s best performing asset classes, up more than 6 percent year to date …

In fact, international investors have been flocking INTO US dollar assets all year, with net inflows of $68.6 billion in September alone going into US stocks and bonds, the most in almost a year!⁶

Consider this, just a week after the US Congress officially announced failure in its deficit reduction talks, US consumers still confidently spent a record $52.4 billion over this past weekend as retail sales soared 16 percent. This further underscores the fact that in an uncertain world, the strength and stability of a dynamic US economy is perhaps the very best place on earth to be investing right now.⁷

So be wary of the doom-and-gloom scenarios many financial writers like to paint. In many cases they have no skin in the game, nor do they have any direct knowledge of your personal investment circumstances.

As Banyan’s Director of Fixed Income Steve Chapman points out, “In my three decades-plus of managing clients’ money, I’ve yet to witness a single one of these ‘end-of-the-world’ scenarios actually result in the dire consequences predicted.

“No doubt, the global economy faces serious issues today that require proactive and swift action to stabilize markets. However, looking back — 21 percent prime rates, the Savings & Loan Crisis, Long Term Capital Management, even the Great Depression — have all impacted our economy, but in time we have always bounced back stronger.

“What perhaps is most disconcerting to me as a money manager is witnessing investors who actually make decisions about their money based on doomsday scenarios and ultimately lose money unnecessarily.

“There’s an old saying, ‘You are what you eat.’ My advice is change your diet and stick with experienced professionals who do this for a living. Cool heads and solid strategies prevail. Noise never does.”   

Visions of financial apocalypse may be good for boosting TV ratings or newsletter subscriptions, but acting on such faulty forecasts could prove hazardous to your wealth, not to mention your mental health.

Good investing,

Mike Burnick
Director of Client Communications
Banyan Partners, LLC

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¹ Bloomberg news, 11/21/11
² Center on Budget and Policy Priorities, 11/17/11
³ IHS Global Insight Perspectives, 11/21/11
⁴ First Trust Commentary based on CBO data, 11/16/11
⁵ Center on Budget and Policy Priorities, 11/17/11
⁶ Bloomberg news, 11/21/11
⁷ Bloomberg news, 11/27/11